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Author: TMFDiogenes One star, 50 posts CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 236  
Subject: NLY Bear Case Date: 11/16/2010 3:29 PM
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A commenter at http://bit.ly/dhlVtE did a great job of laying out the bear case for NLY:

"Surely it is folly to value a business by its dividend yield.

Its PE of 13 and price to book of 1.2 show it to be fairly valued for a business with no competitive advantage and little prospect of growth without raising fresh equity.

'The most likely outcome is that the economy will remain sluggish, interest rates stay more-or-less favorable, . . .' i.e. you mean to say that the spread between long rates and short rates (currently the highest in over 30 years) is going to remain there for the next two years.

Your wish may well come true (I'm the last person who will try to predict the economy or stock prices.) And I do subscribe to the view that there is certainly something wrong with every great investment (which is the reason everyone else is running away.)

But in uncertain times, most experienced investors will look at the worst possible outcome as well as the best. Hence the reason for the 17% yield.

The other possible outcomes are that QE succeeds and long term rates drop, resulting in a squeeze on NLY.

Or QE succeeds and after six months inflation picks up resulting in short term rates starting to go up and another squeese on NLY.

NLY is fairly valued, buying based primarily on dividend yield is a poor strategy. Be guided first by intrinsic value and only then look at the dividend."



First, we're not wishing that the economy continues to muddle along -- that's just a prediction.

To respond to the issues raised by QE2. Of these 3 possible outcomes over the next year or two:

1. Modestly lowers lt interest rates
2. Dramatically lowers interest rates
3. Inflation

Since QE2 is a fairly modest plan: QE1 was $1.9T -- figures I've seen put the effect at a 2 percent reduction. QE2 is just $600b. Rates are already rising since the plan was at the low end. To really have an effect and perhaps cause inflation to the point of rising interest rates, it'd probably have to be a few trillion.

That's why outcome number 1 appears the most likely, despite the punditry's freakout about QE2.

If the spread stays about where it is, the dividend should stay big for now. Even for a more-or-less fairly valued stock, a 15% yield isn't anything to sneeze at these days.
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